Big Blue, IBM, announced that yesterday that it reached a deal with cloud computing firm Red Hat to acquire them for 33.4 billion. A 62.84% premium on the stocks last traded price.
Red Hat is a software firm specializing in open-source computing tools. The firm is a market leader at developing enterprise computing infrastructure and applications using Linux. They also provide database, content; and collaboration management applications; server and embedded operating systems; and software development tools. This in addition to consulting, custom application development support, and training services.
Why Red Hat?
Redhat’s LTM Revenue is placed at 3.2 billion with their net income coming in at 288 million. This revenue is earned through Red Hat’s business model of mixing free, open source software and subscription-based support, training, and integration services. Thanks to this model much of Red Hat’s revenue is recurring, roughly 60% to be precise.
So what makes them appealing to IBM? Sure they have strong yoy net income growth of 20.9% but its weaker in relation to its competitors. So what makes Red Hat 33.4 billion dollars interesting to IBM? Its simple, Cloud computing.
Cloud Computing
Red Hat not only makes open source Linux enterprise computing infrastructure, they also build software for the purpose of developing applications and managing cloud environments. It’s almost become common knowledge now that cloud computing is the future. Companies such as Microsoft and particularly Amazon are betting big on cloud computing. Azure and Amazon web services represent 51.8% and 13.3% of the public cloud infrastructure as a service as of 2017 (Statista). Take particular note of the absolutely massive market share Amazon commands in the cloud computing sector. Most people don’t even know that Amazon does things other than e-commerce, but they managed to gain leading market share early. Other Firms such as Microsoft and IBM are now playing catch up to Amazon, and this is where we find justification for IBM’s massive acquisition.
Market Share & Growth
IBM represents 1.9% of the cloud computing market, their 2016 – 2017 growth was measly .3%. IBM did start late in the game, they only entered the cloud computing market in 2016 and have been looking for ways to catch up to their competitors. Red Hat is that first big effort.
Red Hat represents 1.85% of the cloud computing market, which means that IBM has just doubled their current market share and will now surpass google to become the 4th largest in the sector by market share.
New Value for IBM
We think this is the right move by IBM, Red Hat is more experienced in cloud computing and this acquisition is more than just market share. IBM will gain valuable expertise to better assist them in growing their cloud computing interest. We feel this move will also reflect well in IBM’s share price.
For some time IBM’s growth has slowed, simply because they are so dominant in B2B computing there isn’t much room left to grow. Cloud computing offers a new market for IBM to attain new growth from. Gartner projects the overall cloud computing market to grow to 302.5 billion, plenty of room for IBM to return to positive revenue growth.
